Arm's Smartphone Monopoly: IPO and Beyond

1 minutes reading time
Published 8 Sep 2023

The story of Arm's rise in the global chip industry is fascinating. With early funding from none other than Apple and crushing competition from Intel, the history of Arm took lots of unexpected turns but eventually led to a smartphone monopoly. This article highlights pivotal moments in Arm’s business history, competitors’ mistakes, and explains the company’s high-margin business model. Here’s the monopoly that you’ve never heard of.

Backed by Apple

You might recognize the name Arm from when NVIDIA tried to acquire the company for $40 billion in 2020. However, the plans were scrapped when both regulators and other major companies in the industry raised anti-competitive concerns. What few people know is that Arm was established in 1990 as a joint venture between Apple (at the time, Apple Computer Company) and two now defunct partners, with the initial goal to challenge Intel’s extremely profitable monopoly within the PC chip industry (the x86 architecture). Arm's plans to disrupt this PC industry failed miserably though. Intel’s x86 architecture, much thanks to its partnership with Microsoft and its Windows operating system, was basically impossible to challenge at the time.

Arm Computer
Arm had a hard time competing with Intel and Microsoft

The Intel and Microsoft Alliance

Intel’s fortress-like position in the PC chip industry was not just due to technical prowess or marketing efforts. An important factor in Intel’s success was its strategic partnership with software giant Microsoft. Together, they formed a formidable alliance, commonly referred to as “Wintel” (Windows + Intel). Microsoft’s Windows operating system, which quickly became the de facto platform for personal computing around the globe, was intricately optimized for Intel’s x86 architecture. This meant that PCs running on Windows needed Intel’s processors to work.

Challenges for Arm

For Arm, the challenge was multifaceted. Not only did they have to engineer a chip that was technologically competitive, but they also had to convince both PC manufacturers and software developers to pivot away from an established, efficient, and behaviorally ingrained ecosystem. This ecosystem had deep-seated network effects: more users on Windows led to more developers building software for Windows, which in turn attracted more users. Breaking this cycle, especially when Intel’s chips were already widely adopted and optimized for the world’s number one operating system, was a Herculean task.

The Blunder of a Century

Intel's x86 architecture might have been unmatched for PCs, however, it wasn’t nearly energy-efficient enough for portable devices that ran on batteries. Arm's architecture on the other hand, proved to be remarkable in this endeavor – making it the obvious choice for devices like Nintendo’s Game Boy, and Apple’s Newton (1993). The latter of which – despite causing a lot of headache for Apple – sort of became the launch pad for today’s iPhone. This is how Arm came up with its very lucrative – plus 95% gross margin – licensing- and royalty-based business model.

Arm Apple
Apple used Arm's architecture in the Newton

The thing is though, Intel had an incredible opportunity to become a leader in this soon-to-be gigantic industry, but they decided not to. In fact, Apple in 2006 offered Intel to design and manufacture the processor for its new product – the iPhone – but Intel's then CEO Paul Otellini told Steve Jobs no. Intel believed smartphones would only become a niche product, and did not want to dilute its high profit margins by pouring billions into this new vertical. This was the reason that Apple later turned to Arm and started designing their own chips using Arm's architecture instruction sets. A fun fact about this period is also that Samsung, now Apple’s largest smartphone competitor, manufactured the first iPhone processors up until the iPhone 4, before Apple started its in-house design machinery.

An Exploding Market

Back then, almost nobody could of course imagine how large the smartphone market would become, or how important it would become for the semiconductor industry. Today however, it accounts for almost a third of the global spend on semiconductor design and manufacturing, and Apple's own A16 Bionic processor is arguably one of the most advanced pieces of technology ever created. Apple's A16, introduced in iPhone 14 Pro, is designed using Arm's CPU IP and can in fact only be manufactured by one single company – Taiwan Semiconductor Manufacturing Company (TSMC) – in one single factory. It was the first-ever 4nm (nanometer) transistor processor in a smartphone. With iPhone 15 Pro, Apple, Arm, and TSMC will likely push the boundaries even further, taking it to 3nm – which means each transistor will be just a little bigger than a human DNA strain (~2.5nm).

Enormous progress has been made in the last decade, and since 1960 the number of transistors per chip has increased from under five, to over 130 billion. Moore’s law in full swing.

Arm's Global Monopoly

Today, Arm estimates that their CPU's are powering over 99% of the world's smartphones. The company's revenue is based on royalties and licenses – hence the >95% gross margins, and judging by this quote from Arm's prospectus, this will likely not change in the near-term:

"With the complexity of CPU design increasing exponentially, over the past decade no company has successfully designed a modern CPU from scratch."

Since inception, over 250 billion Arm chips (hundreds of billions of devices) have been shipped, of which over 30 billion last year alone (FY23).

Arm Architecture

The Royalty and Licensing Business Model

Arm’s business model is, thanks to its asset light nature, very lucrative. Rather than producing and selling chips themselves, an incredibly capital-intensive endeavor, Arm’s business is based solely on intellectual property. Arm licenses its architecture to companies that want to manufacture off-the-shelf chips, as well as its instruction sets to companies that want to design their own Arm chips – like in the case of Apple.

Arm’s customers then take these digital chip designs to a foundry like TSMC who in turn manufacture them. When the physical chip has reached its desired quality, it soon enough reaches a company like Foxconn that assembles the final product. And, on top of the license fee, every time a device powered by an Arm-based chip is sold, Arm earns a royalty. In essence, Arm is monetizing its intellectual property without delving into the resource-heavy world of manufacturing.

Arm's Royalty Revenue
Arm's royalty revenue by cohorts

The Barrier to Entry in Modern CPU Design

Designing a cutting-edge processor, or CPU, is an incredibly complex and costly undertaking even if you rely on Arm’s established architecture. The challenges aren’t merely technological but also encompass the need for massive research and development spending. The cost to develop a chip like Apple’s aforementioned A16 would measure in the hundreds of millions of dollars, and it wouldn’t be cutting-edge for long.

Over the past decade, the complexity involved in and the costs associated with chip design has grown at an exponential rate. This is due to the demands for higher performance, greater energy efficiency, and the integration of diverse capabilities into a single chip — all while ensuring compatibility with a multitude of devices and applications.

This chart from Arm’s 2023 IPO Prospectus is great, showing how costs rise as chips become more advanced.

Cost of Chip Design by Nanometer
Cost of chip design by nanometer

Given the high barriers to entry and the ever-increasing complexities, Arm's assertion suggests confidence in their sustained smartphone dominance. New entrants attempting to design a competitive CPU from scratch would not only have to overcome the technical challenges but also vie against Arm's entrenched position in a market where its designs are near-ubiquitous. Two other interesting players in the chip design space (EDA/IP) are the software giants Cadence and Synopsys.

The Arm IPO

As of September 14th, 2023, Arm started trading on the public market and the largest IPO in nearly two years was a fact. It was a warm welcome, and the company opened trading at $56.10, a 10% increase from the set IPO price. It didn’t stop there however, and as the closing bell rang the Arm stock price had soared a total of 25% to $63.59, giving the company a valuation of almost $70 billion.

In Conclusion

Arm's rise to global dominance in the smartphone industry was not a linear path, shaped not only by their own innovations but also by a series of unfortunate decisions by competitors like Intel. With their CPUs powering virtually the entire world's smartphones, combined with a lucrative licensing- and royalty model, Arm stands as an exemplary case of how market foresight, technical acumen, and strategic alliances can drive a company to the height of an industry.

Learn more about Arm and the semiconductor industry